Innovation can be stimulated through taxation

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It was the subject of comment from French presidents, primetime TV shows in America, and the Bundestag – almost none of it positive. In some cases the focus was the nominally low rate of 12.5 per cent and in others the spotlight was shone on some of the practices which resulted in companies paying even lower effective rates – the so-called “double Irish” being the most notable.

According to KPMG tax partner Conor O’Brien this criticism is misplaced and should more properly be directed at the countries which are mainly responsible for setting the global taxation rules.

“Our principal tax offering to overseas companies setting up here is the 12.5 per cent rate of corporation tax,” he says. “That is well known but typically what a global technology company will do is have a manufacturing location here, locate the company which owns the intellectual property in a country like Bermuda which has no corporation tax, and have the company which actually researches and develops the technology in America. The Bermuda company pays the American company a fee for the development of the technology and the Irish company pays the Bermuda company licence fees for its use. When people talk about very low rates of corporation tax they are usually talking about a blending of the Irish rate and the lower rate where the intellectual property is located.”

The question which arises is what share of the profits should be attributed to the three different locations.

Naturally, the aim of the company is to maximise the amount attributed to the jurisdiction with the lowest tax rate. “This takes us into transfer pricing and there are various international norms used to decide this”, O’Brien explains. “The arm’s length principle applies. The firm which develops the intellectual property might have it manufactured by a contractor in a different jurisdiction. If the intellectual property was not developed in Ireland you would not expect a lot of the tax to be paid here.”

But Ireland is not really the problem in all of this. At least some real activity is taking place here. The main issue is the location of subsidiaries in jurisdictions where companies may not have any staff at all, just a brass plate on a registered office address. There is talk of the US moving against this practice by requiring firms to have a “substantial presence” in locations to which they are attributing profits.

This is similar to what is happening in the OECD with its examination of the base erosion and profit shifting (BEPS) issue. “There are different schools of thought at present”, O’Brien points out. “On the one hand some say that companies should only be able to accumulate profits where they have a substantial presence. But the US is looking at it slightly differently. They are saying that where the capital is located also counts and if capital has been risked in the development of the intellectual capital the profits can be attributed to where that is located. Of course, if the project goes wrong the tax loss on the investment will be worthless as there is no corporation tax to pay.”

Tax incentives

If the US view prevails this would mean that not a lot would change as far as many technology companies are concerned. But why all the fuss if that’s the case? “If you look at it from the US point of views the BEPS debate is an attempt by European countries to grab tax from US companies. Modern tax rules were set by the big powers back in the 1920s and the rules were that the tax was paid where the goods were manufactured. This suited the big manufacturing powers at the time. Now the European countries want the tax on technology companies to be paid where the products or sold but they don’t want that to apply to German cars or French wine.

Similarly, it is not in the best interests of the US to have American companies paying higher taxes overseas as this affects the amount of profits they can repatriate and the amount of tax they will pay there. There is a remarkable coincidence between the self-interest of the countries involved in the debate and the so-called principled stands they are taking on the BEPs issue.”

While there might be little Ireland can do to influence the international power politics at play in the BEPS negotiations there are some tax changes which can be made in tomorrow’s Budget to make it more attractive for overseas companies to locate their intellectual property development and ownership in this country.

“The core of our offering is the 12.5 percent rate, it is not just low but it has been consistent. Since the 1950s we have been offering an attractive corporation tax rate and we have kept out promises. It is supported by all parties in the Dáil and we managed to hold onto it during the bailout in the face of tenacious pressure from outside. But outside of that there are a number of things which can be improved.”

Chief among these, according to O’Brien, is the tax treatment of foreign nationals who come to work in senior positions in overseas companies located here. “We need to make it attractive for these key people to come and work here”, he says. “If it is not, they will go somewhere else. It was attractive until 2006 when the remittance basis of taxation for those individuals was ended. In my view this was our biggest industrial policy mistake. It was done at the height of the boom when people had become complacent. We are aware of large-scale projects that would have come here but were cancelled as a result of the change. We also know of people who have left the country because of it and projects which subsequently did not come here as a result.”

There was an attempt to improve matters through the Special Assignment Relief Programme but this is overly complex to be attractive. “It is too difficult and complex. I think only nine people have availed of it so far. The remittance basis was straightforward and we are no longer competitive without it. We need something similar again. We are on Europe’s periphery and we don’t have oil or natural resources, we need to give people a reason to come and live here.”

He also believes changes could be made to encourage and incentivise innovation by domestic companies.

“Capital gains tax has gone from 20 percent to 33 percent here. That’s very high. In the UK it is 10 per cent for entrepreneurs. Our bankruptcy laws are also quite brutal. In the UK you have the stamp of bankruptcy removed from your name after one year and you cease paying your creditors after three. Here it is between five and eight years, in the US it is zero. If we want people to leave a job and have a go at starting their own business you shouldn’t punish them for failure. It’s a risky endeavour and lots of businesses fail and entrepreneurs shouldn’t be punished if they haven’t behaved fraudulently or recklessly. They should also be rewarded by the tax system. We recommend that entrepreneurs should be taxed at a rate of 10 per cent on dividend income to offer a further incentive.”

He believes that changes to the tax treatment of key people in overseas companies and domestic entrepreneurs can be drawn tightly enough to prevent abuse but not so tight as to be impossible to comply with.

“It would be possible to draft the changes tightly enough but not so tight to end up in a situation like SARP. I hope the minister will take action on these issues in tomorrow’s Budget.”